What You Don’t Know Can Tax You

I was reading an article on a recent tax court decision in which the court trial was borne out of an examination of an individual taxpayer.  One passage from the article read as follows:

“The IRS auditor analyzed the taxpayers’ bank statements and records to identify total deposits and asked the taxpayers where the deposits came from.  Deposits for which the taxpayers could not identify the source were classified as taxable by the auditor.”

There’s a lot to unpack here, but before we get started, let’s discuss some background items.

A few general facts

First, the fact that this case is an individual exam is irrelevant to you the reader.  As I teach in my classes, you and your business are one and the same.  Therefore, in any exam, an auditor will audit both you and your business.  Even if your business is a separate entity.  There is no hiding behind separate entities.

Second, any exam is going to carry on for multiple years; three years is the most likely scenario to start.  If you’re unfortunate, it will only grow from there.  Outside of certain circumstances, the IRS can generally audit any of the last three years filed.  So as of December 2019, the IRS can freely audit 2016, 2017, and 2018 returns.

Third, while I’m an accountant and have a different perspective, I know taxpayers generally don’t keep accurate “books and records” for themselves.  How do I know?  Easy.  Every time I go to the bank, the teller asks me, “Do you need a balance?”.  The accountant in me thinks this is quite possibly the worst question ever asked because the bank never has a correct balance.  However, it seems to be of great service to the general population because the bank keeps asking.  Thus, the fact that a bank, who never has the correct balance, is better than the individual’s own records tells me the individual must have less of a clue than the bank as to what their correct balance actually is.

Unpacking the details

With that background established, let’s start unpacking the passage in the article, kind of like you would  your favorite Bible verse:

First, the auditor analyzed ALL the taxpayers’ bank statements and records. So, if you have four bank accounts, you’ll be required to hand the examiner 144 statements (4 accounts for 12 months for 3 years).  No exceptions. Keep in mind, a lot of online banking services only go back one year and we as individuals don’t keep good records. Thus, you could very well need to pay for nearly all the statements to be reproduced. As of December 2019, the only statement available to us online for our 2016–2018 exam is December 2018.  Yikes, that’s a lot of bank charges!

Second, the auditor added up total deposits on the bank statements. An auditor will subtract transfers between accounts, which could be documented if they are done electronically.  However, if you’re writing a check from one account to the other, even a transfer may not be documented clearly.  After this, the auditor compared TOTAL ADJUSTED DEPOSITS to known income. It’s extremely important to know an examiner will ALWAYS do this analysis – either for a business or individual. They are looking for unreported income.

Next, the auditor was nice enough to ask the taxpayers where the deposits came from. Nice, huh? We all assume it would be the auditor’s job to figure out sources and amounts of income.  However, that’s a very bad assumption. We, as either businesses or individuals, need to know the sources for all our deposits.  It’s not for the IRS to figure out.

As a result, “Deposits for which the TAXPAYER could not identify the source WERE CLASSIFIED AS TAXABLE.” Think about that for a moment. EVERYTHING not identified was classified as taxable.  EVERYTHING. You’re probably thinking, “That’s not fair!”. It certainly isn’t. However, auditors have a godlike power. They can pretty much do anything they want. That’s just the way it is.

So, let’s think about this in terms of ourselves. We have already determined individually we don’t keep good books and records.  So that $350 deposited on 7/6/16.  What was that?  Don’t know? Bam! Taxable. That $890 deposit on 8/31/17.  What was that?  Don’t know? Bam!! Taxable. In reality, these could have been insurance refunds; redeposit of left-over cash you took on vacation; your kids’, family’s, or friends’ reimbursement for some expenses; mileage reimbursements; legitimate gifts; and on and on. ALL OF THAT IS NOW TAXABLE because you were too lazy to keep a simple check register. This is now rubbing salt in the wound after you had to pay to obtain the bank statements.

For rainy day Monday fun, I looked at my own records. While I do, in fact, know where and what all my deposits are for, I pretended I didn’t have good records, or any at all. I can prove my wages and account transfers.  But again, I’d have no way of remembering or proving insurance refunds, tax refunds, expense reimbursements from my kids, or my sister giving me cash as a reimbursement for my parents’ anniversary present, some small court settlements, etc. For one year, the total was $4,995. So over three years, that would mean $15,000. While $15,000 isn’t enough to rise to the level of fraud, it is enough to cause a lot of hurt. If we assume a fairly common tax rate of 24%, that would mean an examiner could assess me with an additional tax of $3,600 in an exam BEFORE penalties and interest. Now we’re taking sandpaper to that wound.  Again, all because I was too lazy to keep a simple check register.

Keep in mind, I did nothing wrong. I correctly reported all items of income and deductions correctly under the law. I just was lazy with my recordkeeping.  Now I’m out $1,440 – $3,600 for bank statement copies that cost me $10-$25 per copy, $3,600 in assessed tax, and hundreds more in interest and penalty. Lastly, I may want to have someone represent me in an exam. That could easily cost me another $3,000 – $5,000.  Remember, since I don’t have good records, the guy charging $200/hour is going to have more time than if my records were good. And after all this, I HAVE NO DEFENSE TO APPEAL THE DECISION.

Yes, this is very real and can happen.  I’ve seen it.  Remember, as you suspect with the IRS, you are guilty until proven innocent. What you don’t know can indeed tax you.

 

BrentThompson fromwebBrent Thompson, CPA has been with Canon Capital since 1998. He provides management advisory services, tax and general business planning, tax preparation, and financial statement preparation and review services for numerous businesses and their owners. He holds the Certified Management Accountant (CMA) designation and a Chartered Global Management Accountant (CGMA) designation. Brent is a member of the AICPA and the Institute of CMA’s.

This article is designed for general information only. The information presented should not be construed to be formal advice nor the formation of a client relationship.

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Craig Covington

Owner & Technical Consultant

Craig serves as a Technical Consultant on the Canon Capital Technologies team, guiding business clients through all aspects of Managed IT Services, Network Security, Data Backup & Recovery, and Help Desk Support. He also leads sales and marketing for the Technologies business unit. He has a business degree from Delaware Valley College and an MBA in Marketing from LaSalle University.  Prior to joining Canon Capital in 1998, Craig worked as a general manager of a car wash, as a controller of a heavy equipment company, and as a senior technician for a major home improvement company.  Craig is a Microsoft Certified Professional.  Craig also serves as executive director of Healthy Neighbors International, a non-profit medical missions organization serving in Nicaragua. Craig resides in Doylestown with his wife and has four children. He enjoys spending time with his family.

Computer Recycling Program

In an effort to support our environment, provide our customers with a cost-effective, easy way to dispose of their unused computer equipment and comply with local equipment disposal laws, we are announcing a new computer equipment recycling program. Here’s how it works:

At your request, we will recycle your used computer equipment for you. Computers will have their hard drives rendered inoperable (so that there is no possibility of anyone extracting data from them). We will then transport your equipment to a certified computer equipment recycling center for proper disposal.

To encourage as much participation in this program as possible, we are keeping the fee for this service to a minimum. To have your computers recycled, simply:

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Computer Equipment Recycling Program (PDF)

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Minimum Wage Rates on the Move in 2020

While the Federal minimum wage has remained at $7.25 per hour since 2009, the minimum wage is on the rise in many states, counties, and municipalities across the United States.

We have seen increases in the minimum wage as nearby as Philadelphia, where city contractors, subcontractors, and municipal government workers began receiving a minimum wage increase on a schedule, with plans to continue raising the minimum wage according to the Consumer Price Index for all Urban Consumers. New Jersey residents saw a similarly scaled increase to the state minimum hourly wage, with plans to grow it from $8.85 to $15.00. Legislation has been proposed to raise Pennsylvania’s minimum wage via State Senate Bill 79, which currently is under discussion in the State House Labor and Industry Committee.

How has the minimum wage changed across the United States? Here is an interactive map providing a current overview.

We are happy to answer any questions you might have regarding these updates or any other issue related to your payroll. Call 215-723-4881 or contact us online.

Kent Gerhart

Owner & Director of Technologies

Kent has over 35 years of experience in the computer systems and services field as a computer programmer, analyst, operator, and consultant. Before joining Canon Capital as the Director of Technologies in November 2000, he was the owner of KenTech Information Systems, Inc. from 1991-2000. Kent maintains authorizations with technology companies such as Microsoft, Datto, Inc., Altaro Backup, Hewlett Packard, Calyptix Security, and Axis Communications. His education in finance and computer systems comes from Montgomery County Community College and Ursinus College. Kent serves on the board of directors for DCP Theatre in Telford, is a United Way volunteer, and is House Church Shepherd with Renew Community Church in Lansdale. Kent and his wife, Cindy, reside in Telford and they have three grown daughters. Kent’s hobbies range from music (guitar, piano, worship leading), acting in community theatre, and ballroom dancing to doing “handyman” projects.

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IRS Issues New Mileage Rates for 2020

It’s a new year so that means it’s time for the IRS to issue new mileage rates. These are the optional standard mileage rates used to “calculate the deductible costs of operating an automobile for business, charitable, medical or moving purposes.”

The 2020 mileage rates are:

  • 5 cents per mile driven for business use (a half of a cent decrease from the 2019 rate)
  • 17 cents per mile driven for medical or moving purposes (a three-cent reduction from the 2019 rate)
  • 14 cents per mile driven in service of charitable organizations (no change)

The IRS website notes that “under the Tax Cuts and Jobs Act, taxpayers cannot claim a miscellaneous itemized deduction for unreimbursed employee travel expenses. Taxpayers also cannot claim a deduction for moving expenses, except members of the Armed Forces on active duty moving under orders to a permanent change of station. For more details, see Rev. Proc. 2019-46 (PDF).”

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